Currency crisis persists after Mugabe

IN 2017, Zimbabweans marched against their own government, in the usually sweltering heat of November, and turned the heat on their president, forcing him to resign thus confirming the age-old adage that in politics no-one is indispensable. Like the proverbial frog in warm water amid rising temperatures, former president Robert Mugabe had tried to withstand the heat.

Colls Ndlovueconomist

While that tragic episode of Zimbabwe’s history has now waxed and waned, the bond note still serves as a grim relic of that era and should have long been discarded.

Zim $100 000 000 000 000 000 000 000 000

The figure above is the last official currency issued as legal tender by the Reserve Bank of Zimbabwe (RBZ) (if you add back the 13 zeros that were slashed off the Zim$100 trillion note issued on January 16 2009) just before the introduction of the multi-currency system on January 29 2009. A cursory look at Zimbabwe’s financial history shows that in 1980, the bank notes that were in circulation were Zim$2 to Zim$20. The Zim$1 was equivalent to US$1,50. Inflation stood at 5%. Between 1994 and 2006, new notes ranging from Zim$50 to Zim$100 000 were issued for the first time. In January 2008, the Z$1 million to Z$10 million notes were introduced and, in perfect correlation, hyperinflation ballooned to 100 000%.

From May 2008 to January 2009, bank notes ranging from Z$100 million to Z$100 trillion (plus 13 zeros) were issued, and hyperinflation went to a trillion%.

The above paragraph seeks to explain what caused the death of the Zimbabwean dollar. It was killed by bad economics and the RBZ’s printing press. Every excess dollar printed caused a corresponding increase in hyperinflation.

Enter multi-currency system

On January 29 2009, Zimbabwe formally dollarised by adopting the multi-currency system. Dollarisation entails the de jure (official) abandonment of a country’s own currency and ipso facto the adoption of another country’s currency, generally the US dollar, as its legal tender.

The use of the multi-currency system tends to eliminate the risk of exposure to sudden, sharp devaluation of currencies since consumers are free to switch from one currency to the other with relative ease. The United States dollars circulating in a country like Zimbabwe are indeed credibly backed by the full might and credit of the US government, but such US dollar deposits are subject to the whims and caprices of the Zimbabwean government which can, at the stroke of a pen, abolish their legal status. The ongoing threat on Real-Time Gross Settlement balances is a case in point.

Gresham’s law

The propensity to print money is an ever-present human phenomenon. The present multi-currency system managed to cure the country of the scourge of hyperinflation, reducing it from trillions in 2008 to below 0% as at September 2016 (just before the bond note).

The impact of the introduction of bond notes into the multi-currency system at 1:1 to the US dollar caused inflation to rise (reportedly above 20% this week). Financial strife and severe liquidity shortages are already afflicting the economy. The dreaded black market is back with fury.

As Milton Friedman said: “Inflation is always and everywhere a monetary phenomenon caused by excessive printing of money.”

The reason why Zimbabwe’s inflation rate had remained at below 0% since dollarisation is that the RBZ could not print money. Now with the bond notes, the RBZ is printing, hence the 20,85% inflation.

The adverse effect of decreeing that the bond note should rank pari passu with the US dollar is that the bond notes eventually drove US dollars out of the Zimbabwean financial system. By prefixing the exchange rate at 1:1, the RBZ was setting Zimbabwe up for Gresham’s Law (bad money driving out of circulation good money). This occurs where the government fixes the exchange rate between two currencies. With time, one currency will become overvalued while the other becomes undervalued. The undervalued currency then disappears from circulation. Fixing the US dollar at 1:1 to the bond note had the effect of undervaluing the US dollar. The US dollar disappeared from the financial system.

Currency question solution

Up to 2015, one could withdraw up to US$5 000 from an automated teller machine (ATM) and, up to US$10 000 from tellers inside a bank. That is how liquid the financial system was just before the introduction of the bond note.

Thereafter, an ominous rumour about a new currency called a bond note surfaced and gained traction. It was said that this currency would exchange at 1:1 to the US dollar. This obscure currency caused capital flight, with consumers hoarding the US dollar. The financial system began to experience the acute shortage of foreign currency. Given the ongoing currency debate now led by Finance minister Mthuli Ncube, the question which arises is: which currency would suit Zimbabwe?

Ncube gave three options: the first being the adoption of the US dollar. This would entail the exclusive use of the US dollar excluding the other concurrent currencies like the rand, euro, bond note, etcetera.

Instead of adopting the US dollar only, Ncube should rather remove the bond note and keep the multi-currency system, inclusive of the US dollar. This would restore the multi-currency system to its pre-bond note position. The removal of the bond note from the existing multi-currency system can have the immediate effect of restoring confidence, bringing certainty and stability to the financial system.

Using the US dollar as pricing currency, but within the multi-currency system (minus the bond note) would suit Zimbabwe better than using the US dollar only without any currency choice for consumers. Invariably, the US dollar will assume a dominant role and become the currency of choice. Adoption of the US dollar only will prejudice consumers receiving remittances in rand. The second choice mooted by Ncube is the adoption of the rand through joining the Rand Monetary Union. Ncube needs to be told that the rand is already a de jure legal tender in Zimbabwe within the multi-currency system, it would be better to merely use it de facto as a main pricing currency without necessarily joining the rand union. That way, Zimbabwe will enjoy the benefits of the usage of the rand without the onerous contractual obligations that come with joining the union.

If the rand starts depreciating pursuant to South Africa’s land reform, Zimbabwe can switch to other currencies within the multi-currency system like the US dollar.

Insofar as the bond note is concerned, Ncube must state without any equivocation or ambiguity that he will remove the bond note once and for all before end of 2018 and immediately announce a timetable for its removal. This assertion must be emphatic and resounding in order to win market confidence.

Regarding the demonitised Zimbabwean dollar, a strong message must be sent out that this currency will not be re-introduced anytime soon. The Zimbabwean dollar issue will be for future generations to bring back, not now. That way, Zimbabweans will begin to see building cranes hovering over the skies of Harare and Bulawayo just like one sees them in Johannesburg.

Confidence and investment will come to Zimbabwe with a bang. Currently, what keeps investors at bay are the twin evils of the bond note and the potential return of the dreaded Zim dollar. These twin evils of the Zimbabwean economy will perpetually remain the country’s Achille’s heel so long as the country fails to deal with them decisively.

The debate about the potential return of the Zimbabwean dollar should be jettisoned for now given the poisonous nature of the Zimbabwean dollar. Any mention of bringing back the Zimbabwean dollar is likely to spook the financial markets and scare away the much-needed foreign investors.

Production is a function of a credible and reliable currency. There cannot be production so long as the currency is discredited and distorted. Foreign exchange reserves are never adequate to defend a currency.

The generally accepted optimal level of adequate foreign exchange reserves is derived from the so-called Greenspan-Guidotti rule. This rule asserts that the foreign exchange reserves of a country should equal its foreign exchange debt obligations (including imports) maturing within one year. As to whether this level of reserves can adequately back the country’s currency, the resounding answer is no.

The value of a currency depends on the market’s confidence and trust in that currency. Judging by the history of the Zim dollar, especially given that it previously depreciated to zero and was subsequently demonetised, only future generations can have confidence in it.

Central bank independence

Members of the general public have long been suspicious that something is not kosher with their central bank given its previous duplicitous role in causing hyperinflation.

The RBZ is a magnet for many of the tensions that afflict the country. Given its ability to manipulate the currency and influence the distribution of wealth in the country, the RBZ should be a subject of endless scrutiny. The people’s negative views of the RBZ had waxed and waned following the adoption of the multi-currency system in 2009 through to October 2016. The misperception was revived in November 2016 when the RBZ introduced the bond note. A conviction took root that the bond note was the Zim$ in disguise.

A central bank is an instrumentality of the government, an agency just like any other parastatal. The independence of a central bank must be understood to be within but not outside of government.

Admittedly, the RBZ may enjoy intra-governmental independence, but cannot, at the same time, enjoy independence outside of government. From outside government, the RBZ is viewed as part of government and therefore not independent of government. Its actions are viewed as actions of the Zimbabwean government. The independence of a central bank is therefore conditional upon that central bank meeting the expectations of the ordinary citizens through pursuing policies that are broadly acceptable to the people.

It cannot be accepted in a democratic society that a group of unelected individuals can make decisions that affect people in a big way like introducing the bond note and yet remain immune to criticism in the name of independence without being open to full public scrutiny.

Independence cannot be used by central banks as a little bush behind which they want to hide from legitimate criticism. Democratic principles require that the RBZ must be transparent in its capacity as an instrumentality of government if it is to retain the confidence of Zimbabweans.

Ndlovu, a Johannesburg-based banker and economist, was previously with the South African Reserve Bank’s financial markets department, and was winner of that institution’s highest honour, the Governor’s Gold Prize, in 2014. He was previously attached to the International Monetary Fund Institute, in Washington DC. He writes in his personal capacity. Ndlovu can be reached on collsndlovu@gmail.com